Why DryShips Inc. Stock Continues to Collapse

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of DryShips plunged as much as 13% yesterday, and hit new 52-week lows following share price weakness from its majority-owned Ocean Rig UDW subsidiary, further decline in dry shipping rates, and marketwide concern about the global economy.

So what: As stated in my previous article, DryShips owns approximately 78.3 million shares of Ocean Rig. When Ocean Rig goes down in market value, the stock asset value of DryShips also goes down considerably. Ocean Rig is in the drilling business, and oil prices are getting killed along with it. Cheap oil doesn't help the situation, either, because if oil gets a lot cheaper, deepwater drilling projects may become less -- or not at all -- economical for customers. Drilling companies may opt for other land-based projects.

Meanwhile, the dry shipping market, as measured by the Baltic Dry Index, or BDI, continues to get pulverized, down another 1.7% yesterday after falling 2.4% Wednesday. As a reminder, the BDI measures change in the daily spot rates based on a basket of various ships and routes and continues to be significantly lower than this time last year by well over 50% for both the Capesize ships and the Panamax ships. Investors were expecting at least a seasonal rally in shipping rates by now on top of expecting a high-demand/low-supply situation. So far we're witnessing none of this.

Now what: How much lower can shipping rates go? Many dry shipping companies aren't even able to break even on results with rates this low. If this continues, expect to see new-build orders get canceled, which will be helpful in the long term for the industry. Older ships that are more expensive to use due to inferior fuel economy and higher maintenance may finally start to be scrapped and taken out of the world fleet.

Monitor oil prices, because not only do they hurt Ocean Rig but they further expand the world fleet of ships. Cheaper fuel means ships can move faster and make more trips in a month, thus expanding the world supply even further. On top of that issue, according to an article by East Asia Forum, "A less acknowledged consequence of China's emergence is the transformation of incentive structures in the global shipping market."

China has banned the docking of the Valemax ships, which are about double the size of the Capesize ships. This puts shipping in Australia's favor as opposed to Brazil's. The consequence is that since the route from Australia to China is half the shipping distance as to Brazil, far less shipping supply is absorbed. The report also notes: "It is testament to China's weight in global markets that a unilateral move by one Chinese interest group could have such destabilising consequences. The blocking of the Valemax was the result of the fragmentation of China's iron ore industry, and the [hijacking] of policy-making by a particular interest group, against broader national priorities."

This highlights just how risky the dry shipping market is in general from a fundamental basis as well as how sensitive to and dependent on China's demand the industry is. Issues like this are well beyond anybody's control and leave much of the industry at the mercy of China these days.

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